Login with Facebook

Principles of Microeconomics - Producer Theory

In the previous section, we discussed the behavior of the demand curve and how consumers make decisions about what they should buy or leave. We looked at how different factors, including financial, constrains can affect consumer decisions. In the article, we shall be focusing on the underlying behaviors of specific producers using the supply curve. The term "firm" will be used to represent a company involved in the production process. 

The year 1908 saw a great revolution in the automobile industry. The first of these machines can be traced from as early as the 15th century when Leonardo da Vinci built designs and models for transport auto. In 1885, the first gas-powered vehicle was introduced to the market by a German inventor, Karl Benz, followed by the opening of the primary American vehicle producer in 1893. Throughout this period and the previous times, the industry was a luxury only for the higher society. It was simply a revolution on cost and therefore, could not make much change in the industry until 1908.

The American manufacturer, Henry Ford, build a mechanic that slowly decreased the production car, the assembly line. Workers were no longer involved in the production of each part of a car; rather, there were specialized workers to handle specific parts. Here, we see a good illustration of the marginal product of labor (MPL). And this margin increases and the producer increases the workforce. New works create a more efficient environment in the assembly line.

One of the most famous models, Model T, popularly known as "Tin Lizzie," is a folkloric symbol for the American people. This is because it created the turning point where a large number of Americans could afford cars. And by 1927, there were more than 15 million Model-Ts on the market.

We can describe this as an ingenious innovation in productions. It tells us that the economics of a firm bear a vital significance on the whole market – hence we can understand how costs affect supply. 

In a perfectly competitive market:

- Producers make more products if MB (or price) is greater than the MC.

- They will make less where MB (price) is less than MC. 

- They will maximize profits if MB=MC.

- The supply curve represents the aggregate MC of all firms.

The supply or marginal cost curve is represented as a linear and upward sloping. So, how do firms respond to the shocks from demand and supply? We are going to answer this question.

The Producer Theory: Basics

Every firm faces various types of costs, different from other firms. For instance, the costs involved in producing automobiles will be very different from those of fast-food meals. However, we can establish that, at some point, the cost structure of all firms is the same. We can break down in common types.

Let's begin by considering the cost of a firm in the short run. They originate from different input points involved in the production process. A quick run process means there is at least a single factor that cannot be altered – the fixed cost. This is a cost we cannot avoid in the short term unless the firm quits production altogether. The total costs of production is an important consideration for a firm, a starting point in dividing overall costs into two parts; the fixed costs (unchangeable) and variable costs (changeable).

What are the fixed costs?

Let us look at Ford's production line. We can say the firms' fixed costs are the expenses that never changes no matter the production level. Where he produces too little, enough, or too much, the cost remains the same. 

Now, the producer has to open a factory. In this case, Ford needs someone to sell or rent him the space. Luckily, he finds Tom, who is willing to lease a place with a $20,000 one year lease agreement. Once, Ford, has signed the contract, it means he will spend the money, regardless of whether he produces anything or not. This becomes sunk cost because he will never get back the money.

Fixed costs come in many forms. Apart from the sunken cost, there is the costs of equipment and machinery, research and development, and even marketing costs. These costs can vary, depending on how big the firm is.

Variable costs

As stated above, variable costs are those costs that can be changed. They are incurred during the production process. The more a company produces, the more the variable cost. After signing the lease contract and buying machinery, Ford must purchase raw items and hire worker to help in the production of these cars. He will have to hire more workers and buy lots of materials to get the best. 

Marginal product of labor

In an industry that is more labor-intensive, like a barbershop, labor is one of the most vital variable costs. This is because it goes beyond just the hourly wages.

Let's think of barbershop X. Their variable costs include hiring barber. And lets say the shop has to pay $80 per worker per day, where hiring more barbers will increase the quantity of haircuts, depending on how many each barber can produce in a day. 

Note also, that there is the effect of diminishing marginal returns in productions. If there was only one barber working at X, the place would be very busy. He will be responsible for greeting customers, shaving them and cleaning the place. But with more barbers, the advantage of each worker reduces. With only two barber, there is more specialization of labor, leading to a better production. Now, adding eight barbers just to greet people at the door will not have much impact. This is a pattern of diminishing marginal returns. The cost of production begins to rapidly with increased output, which may even result to negative returns. Adding even more barbers will create a rift, making them bump into each other as they move. 

Marginal cost

Where the cost of hiring a barber is $80/day, we can represent the MPL as a variable cost. Assuming the barber can do 15 haircuts per day, we can say the marginal cost per haircut is $ 5.33/haircut (wage/MPL).

When you plot this on a graph with different numbers of barbers, the x-axis changes from "barbers" to "haircuts." We look at productivity by co quantity or workers, and marginal cost by each output level. You will notice that when MPL increases, minimal costs fall. 

Average variable costs (AVC)

With the information we have on marginal cost, it can be easy to know whether more input will be profitable. It is important to know the profit from a single haircut. At times, producers can ignore the variation and calculate the average variable cost by taking the total costs for each worker to a point and dividing by the total number of haircuts.

The intersection occurs at the cost of $4 is build into an economic meaning of MC and AVC. 

The average product of labor

We can use the same analysis as above for the Average Product of Labor (APL), which is also an AVC curve derivative. On a curve, you will notice the APL happens as the minimum point of AVC. This is because costs/haircuts are lowest when, on average, barbers are most productive. 

Average total costs

If barbershop X has fixed costs amounts to $150 per day. The average total cost is calculated as an average of the total variable cost and the total fixed costs. We can use the equation (total VC + FC)/Q. This equation can be expanded into VC/Q+FC/Q, which becomes AVC + AFC.

Consider the graph above. The ATC, for instance, when production 50 haircuts will $4.00. AFC is $150/50 = $3. Hence the ATC us $4.00 = $3.00=$7. 

Notice that the AFC is always falling as Q increases.

Now to understand the Theory

In the section above, we have built the producer theory and explained all the necessary terms.  

Economists use producer theory in non-competitive markets. But in this case, we can study with price-taking firms.

If, for instance, barbershop X is operating in a city in competition with other barbershops, they will not have any control over the price. The market dictates where they produce. As you may already know, economic agents apply marginal analysis when considering behavior changers. We for that Q increase if MD is greater than MC. It will stop where MB is equal to MC.

In this case, price becomes the marginal benefit, since it is equal to the marginal revenue from a process. This means where the price is $7; every Q will earn the firm $7 of the revenue. Here, P is equal to MR and equal to MB. We already know the maximum surplus of a firm occurs when MC is equal to MB; hence, for a competitive firm, it happens when P is equal to MC.


In the producer surplus, there are also fixed costs. But marginal analysis only maximizes producer surplus, not profits. 

We can therefore say; PS = TR – VC = (P – AVC) x Q.

It is only fixed costs that differentiate PS and profit. And even though profits and producer surplus are not the same, maximum PS leads to maximum profits too. 

Using a graph, where PS = (P – ATC0 x Q, we see PS = (7.5 – 5.59) x110 = $210.

Using PS = (P – AVC) XQ, the result will be Producer Surplus = (7.5 – 4.23) x 110 = $360. 

MC = P because it is the profit maximization quantity.

From the figures above, the fixed cost value is the difference between the profits and the producer surplus: $360 - $120 = 150.

In case of losses

When P is greater, the ATC, barbershop X, generated profits of $210 per day. These figures may not be sustainable in the long run. In the short run, firms can produce even when PS is negative. 

Consider when P = $5.

In this case, MC = MB when Q = 90. Hence, ATC = $5.5 and AVC = $3.83. 

The firm is making losses, and you should be thinking perhaps it will shut down, considering the still have to pay $150 as fixed costs. Hence, it is better for the company to take a $45 loss over $150. 

As long as the company has enough to pay for variable and fixed costs, it can still operate. This means PS is greater than 0. However, thoughtful companies will not continue taking losses in the long run. At the shut-down point, the company is only able to cover their variable costs. 

But there can also be a break-even point. The company is not making any profits or losses. 

Looking at the Producer Theory in the Long run

Barbershop X still has to make the long-run decision. Some of the actions the company may have to look into include:

  • When prices are too low under break-even prices. The company may operate in the short run, but abandon operation in LR.
  • The price is under the shut-down price. The company exit in the short run. 

In this case, it is vital to remember barbershop X is a price-taker, operating in a competitive market. Their price is equal to the equilibrium price in the aggregate market. 

If each firm is able to make a profit of $210 in profit after economic expenses, it means this is an attractive industry. But, it is not sustainable in the long-term since other businesses well see an opportunity and join the market. When supply increase, chances are demand will decrease. 

Let's say the number of businesses has grown from 50 to 63 firms, barbershop X's profits may go down to about $52.5 only. If in case the equilibrium price has fallen, there are still positive profits, and the supply will increase constantly. 

At the break-even price, the company will not be making any profits. There is no incentive for more companies to enter, as well. Where the price is below the break-even price, some firms will start exiting the market. 

The most crucial takeaway is, whereas companies make profits (positive or negative) in the short-run, they will always break-even in the long-run.

Now that you understand how a firm behaves in a market and how the market responds to negative and positive profits, you can apply the knowledge using comparative statistics. AlsoMicroeconomics - Producer Theory, the basic tools of the producer theory you have learned should help you better understand microeconomics. 

Introduction to Microeconomics

Principles of microeconomics - consumer theory

Author: James Hamilton

Need a custom

We will write it for you.
Order now

Free Essay Examples

Free essays:

All you need to know about Neuroendocrinology
All you need to know about Big data management
All you need to know about digital special effects
All you need to know Technical Writing?
Basics the Game Theory in Cryptoeconomics
Business innovation ideas for making money
Biosensors for cancer diagnosis
Business Analysis: Pricing strategies and Demand Curve
Cognitive Computing- How does Cognitive Computing work?
Consciousness: characteristics and peculiarities
Conservation Economics
Cybersecurity in business: challenges, risks, and practices
Demographic trends and how they affect Economic Growth
Dance as an art form and entertainment
Discrimination Economics
Determinants of Wages
Everything you need to know about short-term memory
Economic and Policy Impacts of Demographics
Ethics: an essay on the understanding of evil
Emotions: what are they? Theories explained
Factors of Demographic Data Collection
Factors Affecting Purchasing Behavior
Financial Statement Analysis
Factors Influencing Interest and Exchange Rates
Government's Intervention in The Labor Market
Guide on the Pathways of the nervous system
Game theory in microeconomics
Globalization: definition, causes, social impact and risks
How Relativism Promotes Pluralism and Tolerance
How to use the audience’s feedback to write a news report
History of silent cinema
How news report can be strengthened through multimedia
Introduction to Population Problems
Imperfect Information and Asymmetric Information
Imperfect Information in Insurance
Introduction to Labor Markets
Journalism: What is News?
Journalism: Broadcast media and Television Presenters
Journalism: Sources of News
Journalism and Law
Key Determinants of National Income
Key Factors That Affect Pricing Decisions
Kinetic models in biology and Related fields
Know about the different forms of traditional African dances
Latest technology trends
Latest dance trends
Magnetoencephalography (MEG)
Microeconomic Analysis to the Demand for Labor
Neuromuscular disorders
National Economies, Fluctuation, and Responses to Fluctuations
Neurotransmitters: what they are and different types
Nanomedicines to target tumors
Objections to utilitarianism
Organizational motivation and its effects
Overcoming Hiring Challenges for Nonprofit Organization
Population Demographics
Recurrent neural networks (RNN) for speech detection
Russian School of Mathematics
Research and Development
Risk Sharing in Insurance and Asset Markets
Stochastic optimization methods in deep learning?
Structure of the nervous system
Structure of a Corporation
Schizoaffective disorder: how to live better with it
The climate change denial
The techniques of basic cinematography
The Endosymbiotic Theory
The Role of Internal Audit in Corporate Risk Management
Utilitarianism Vs. Kantianism
Understanding Auctions and Auction Theory: Part 2
Various theoretical perspectives of sociology
Virtual reality, what it is and how it works
What are the linear models in machine learning?
What is Convolutional Neural Network
4 Facts about Origin of Mathematics!
5 techniques to create an animation
10 emerging technologies according to World Economic Forum
10 strategies to maximize corporate profits
3d Model Of Building
6 Medical Technologies that revolutionized the healthcare in 2020
All you need to know about the ACA Code of ethics
Architecture and Democracy: An Introduction
Architecture and Democracy: Democratic Values
Architecture and Democracy: Democratic Procedures
All You Need to Know About a Synthesis Essay
An essential guide to understanding Film Theory
Application of Artificial Intelligence in Cyber Security
Applications of electrical engineering
Augmented reality: what it is, how it works, examples
Advantages And Disadvantages Of Social Networking
All you need to know about Cryptography
Applications of astrophysical science
All you need to know about architecture engineering
Applications of geological engineering
Artificial intelligence and medicine: an increasingly close relationship
An insight into Computational Biology
ACA code of conduct
A Rose for Emily
Applications of Mathematics in daily life
Architecture mistakes to avoid
All you need to know about Toxicology
All you need to know about Holistic Medicine
All you need to know about linguistics
An introduction to Linguistics and its subfields
All you need to know about Anxiety disorder
All you need to know about Drones
A Brief Insight into Political Science
Assumptions related to feminism
All you need to know about Byzantine emperors
All you need to know about labour economics
An insight into xenobots -the first-ever robots
An ultimate guide about Biomaterials
A Comprehensive Introduction to the Mona Lisa
Analysis methods of Transport through biological membranes
An ultimate guide about biochemical reactions
Analysis of brain signals
Artificial Gene Synthesis
Application to synthetic biology of CAD methods
All you need to know about metabolic pathways
Applications of BIOMEMS
All you need to know about the epidemiology
Asian vs. western leadership styles
All you need to know about Smart prosthesis
Analysis of Economy: Output of Goods and Services (GNP), and GDP on Economic success
A Guide to Pricing Strategies
An Overview Of Economic Studies
Analysis of Fiscal and Monetary Policies
Analysis of Business Cycles
Analysis of Consumption and Investment
A Look into Regression Analysis
Analysis of Household's Consumption and Savings Behavior
All you need to know about Capital Budgeting
All you need to know about risk management
Art looted in wartime.
Appropriate use of Data in Economics
All you need to know about reaction kinetics?
A historical overview of Financial Crises
All you need to know about management discipline?
An insight into the error-correction models
All you need to know about Data visualization
All you need to know about Work-family balance
All you need to know Technical Writing?
All you need to know about digital special effects
All you need to know about Big data management
All you need to know about Neuroendocrinology
How to Write a Personal Essay
Housing Needs in America
How to Write a Description Essay
How to Create an Excellent Scholarship Essay?
How to write a cause and effect essay
How to Hire the Best Essay Writing Service Provider?
How to Write a College Application Essay?
How to get the most out of your English lectures
How to write Expository Essay
How to succeed in your psychology class?
How to Write an Academic Essay in the Shortest Time?
History of Journalism
How Different Sectors are Using Artificial intelligence (AI)
How to write an informative essay
How to deliver persuasive essays?
How to Give a Convincing Presentation
How to write an essay on leadership?
Historical Art Still Around Today
Humanoid robot: what it is, how it works and price
History of Chemistry
Healthcare Advanced Computer Power: Robotics, Medical Imaging, and More
Healthcare AI: Game Changers for Medical Decision-Making and Remote Patient Monitoring
How to understand different types of English
How to Cope with Chronic Pain
How African American choreographers and dancers have influenced American dance
How mobile robot can do in logistics or in production
How To Become a Successful Entrepreneur
History of the Philosophy of Feminism
How is the climate changing?
How to Track Your Content Marketing ROI
How to Gun control In the USA?
Historical and contemporary role of labour in the modern world
How breast cancers are classified?
How the cells of our body communicate?
How the Lymphatic System Works?
How Digestive System Works
How to complete your capstone projects effectively?
How to write a research project
Healthcare technologies that help patients with better self-management
How to choose the topic of the senior capstone project
How to make your business survive at economic crisis
How can immigrants blend in the American society?
How does the economics of war affect society?
Hate speech on social media.
How to Build an Economic Model
How to start a healthcare startup?
How can financial illiteracy harm you?
How cancer is developed - Cancer biology
How to define the Enterprise Value
How to conduct economic research?
How women can manage sexual harassment
How to use quotes in your news reports?
How news report can be strengthened through multimedia
History of silent cinema
How to use the audience’s feedback to write a news report
How Relativism Promotes Pluralism and Tolerance
Introduction to Urban Studies
Importance of dance in education
InMoov: how to build an open source humanoid robot
Importance of KYC verification to making the Blockchain secure
Importance of Rhythm
Importance of dance student evaluation
I/O control methods -types and explanations
Identity theft: what to do?
Introduction to Utilitarianism
Importance of 3d Modelling in Architecture
Importance of online journalism
Image processing in medical diagnosis
Introduction to USA Politics
Introduction to Comparative Politics
International Relations as a Major in Political Science
Importance of modern trade policy
Introduction to Journalism
Introduction to Writing a TV Script
Introduction of Microfabrication techniques
Introduction to Microeconomics
Interaction of Consumer and Firm Choices in Markets
Importance of corporate sustainability
Issues in International Monetary Macroeconomics
Introduction to Statistics and Data for Economics
Introduction to Data and Probability for Economics
Introduction to the Game Theory
Introduction to Econometrics
Introduction to Economic Information
Introduction to Market Equilibrium
Introduction to Economic Models and Application
Introduction to Empirical Research
Introduction to Econometric Data
Importance of Critical Thinking, Principles, and Goals
Introduction to Identification and Causal inferences
Introduction to Econometric Application
Intermediaries and Government in Financial Crisis
Importance and seven principles of quality management
Illiteracy in the USA
Introduction to Economics of Law
Introduction to Coase Theorem
Introduction to Social Choice and Incarceration
Intellectual Property and Product Liability
Investment in Human Capital
Introduction to Labor Markets
Imperfect Information in Insurance
Imperfect Information and Asymmetric Information
Introduction to Population Problems
The Looming Energy Crisis in America
Top benefits of performance-based engineering
The More Languages You Know, The More Times You Are a Man
Things to consider while writing an Argumentative Essay
Top Ways to Improve Your Academic Writing Skills
Tips to Excel in Creative Writing
The origins of films in the early 19th century
Top career options in Architecture
The Elevator Pitch
Top finance trends 2020
The basic Structure and functionality of robots
The Way to Success
The election system of the President in the United States of America
Two-party System in United States of America
Top trends in urban design
The history and theory of African American filmmaking
Top benefits of creative writing
Tinnitus Guide: Common Symptoms and Treatment Options
The language of dance
The digital image processing management
Top famous politicians of the World
Top methods of political science!
The history of the feminist movement
The blood flow in cardiovascular system - Biofluid Mechanics
The best of Leonardo Da Vinci
The Structure and Function of Macromolecules
The structure of cell: a research on the bricks of the human body!
Tissue and organ construction: Adhesion and recognition between cells
The kinetics of the transformation processes
The Modeling of Biological Systems
Tips for writing a great thesis statement
The Defense mechanisms against infections
The impact of the technological innovations in medicine
Top journalism trends to know about
The relation between mass media & politics
Theranostics: Diagnosis and Care through Nanoparticles
The practical Applications of X-rays
The applications of Ultrasound in medicine
Transfer mechanisms of genetic information in Bacteria
The regulation of cellular metabolism in the diagnosis
The Principles of MRI Contrast agents
The technical basis of optical coherence imaging
The New Media: Emerging Trends
The Structure of Interest Rates and the Yield Curve
Technological perspectives and reflections of neural engineering
Types of bioreactors and their applications
The Role of Government Policy in Improving Economic Outcomes
Types of corporate responsibility
The Role of IMF in International Monetary Macroeconomics
Tools for investment decision making
The concept of Organizational Culture and its applications
The Conduct of Monetary and Fiscal Policy
The Basics of Financial Accelerator Models
Tips for labeling medical devices- Medical Entrepreneurship
The different medical imaging techniques
The Economics of Uncertainty – Introduction
Theories of Public Policy
The Game Theory in Social Media
The political theory of Thomas Hobbes
The Use of Law on Economics and Vice Versa
The Role of Internal Audit in Corporate Risk Management
The Endosymbiotic Theory
The techniques of basic cinematography
The climate change denial
What is a Definition Essay?
What are diagnostic essays?
What is the relation between art structural engineering?
What is a Narrative Essay
What are robotics and intelligence systems?
What are the benefits of studying health sciences?
What is artificial intelligence and why it matters?
What is comparative Literature?
Why study neuroscience
What is Wi-Fi and how does it works
What is French history famous for?
What are Humanistic Studies?
What is covered in Biophysics?
What is modern journalism?
What is Virtualization? Benefits & Applications
What are modern public relations?
What is plasma physics?
What is teacher preparation?
What is rapid prototyping for 3D printing?
What is contemporary European Politics?
Why should you learn American Ballet?
What is engineering physics?
What is the purpose of African American Literature?
Ways to learn the Rhythm
What is digital art used for?
What are Enzymes and how do they work
Who is the father of political science?
Why Study Political Science - Job?
What is the Philosophy of Feminism?
What is a quantum computer?
Ways B2B Startups Streamline Their Conversion Strategies
Why do biomedical signals need processing?
What are the long term effects of climate change?
Why study labour relations
What is Holoprosencephaly?
What is antisocial disorder?
What are the important principles of evolution?
What is the cytoplasm and its function?
What is biopolymers?
What Makes a Good Leader
Women empowerment in modern generation
What is the history of political thought?
What is Gene recombination
What is synthetic biology
What is business cost analysis?
What is Inflation
What are the consequences of unemployment?
What is lithotripsy and its types?
What is transition elastography?
What is the purpose of deep brain stimulation?
What is a Brain-Computer Interface (BCI)
What is neuroethics?
What is Market and Supply and Demand
What is optogenetics?
What are the techniques to record brain activity?
What happens if the interest rate increases?
What is immunotherapy?
What is the economic role of the financial market?
What are the factors behind illegal immigration?
What is the lymphocyte activation?
What is financial market and its types?
What is the structure of financial markets?
What are the methods of measuring business performance?
What is the Credit market?
What is business ethics and code of ethics
What are the Causes of financial instability?
What is MBA with Concentrations
What is regenerative medicine?
What is Population ecology?
What is Microfinance: evolution, and practices?
What is biotechnology and its applications?
What are Workplace diversity and its benefits?
What is the difference between a leader and a manager?
What Is Branding and best branding Business strategies?
Why are microelectronics important?
What are biologic drugs.
What is the Foreign Exchange market?
What is the role of scientific research in times of crisis?
What are the risks of international trade?
What is financial management?
What is gene therapy?
What is education economics?
What is regression analysis, and why should you use it?
What Is Technology Marketing And How Should It Work?
What is Management Accounting
What are the methods of valuation of companies?
What is Immune System and Immunotherapy?
What is big data analytics?
What is the 7 layers of OSI model?
What is Neuroplasticity?
What are Sculpture art and its types?
What are the different genres of films?
What is Transcranial magnetic stimulation (TMS)?
What is TES-Transcranial electrical stimulation?
What is Relativism?
What is Vaccine skepticism, and what to do about it?
What happens in the brain when learning?
What is the deep neural network?
What is Convolutional Neural Network
What are the linear models in machine learning?